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Is it RIP for the RPI?

24 October 2012
The Retail Prices Index has been an official inflation measure since 1956 but a new consultation could spell the end for its current popularity in real estate transactions.  Launched on 8 October, respondents are invited to consider options for bringing the calculation of the RPI in line with the Consumer Prices Index.  The Treasury estimates that annual increases in the CPI are approximately 0.5% lower than those of the RPI.
Is it RIP for the RPI?

Both indices are calculated according to the cost of a notional shopping basket of different kinds of goods and services bought by a typical household.  As the price of those goods and services changes over time so does the total cost of the basket.

The differences between the RPI and the CPI relate to:

  1. population base (the RPI excludes very high and low income households);
  2. commodity coverage (the CPI excludes owner occupiers housing costs); and
  3. the different formulae used to combine prices at the first stage of calculation.

It is this last aspect that is the subject of the consultation currently being led by the Office for National Statistics. The difference between the RPI and CPI figures at shopping basket level is caused by the different calculations: The RPI uses arithmetic averages whereas the CPI uses a mixture of arithmetic and geometric averages.  An arithmetic mean is calculated by adding the prices and dividing by the number whilst a geometric mean first multiplies the numbers and then the root is taken so that the range of prices is evened out.

Although the consultation is primarily about statistical methodology, it will note potential consequences of any change.  Some of these will be far reaching.  As the official measure of inflation, the RPI is used for a variety of purposes including the adjustment to index linked Government bonds.  If the RPI is recalibrated then this could mean lower returns for funds which have invested heavily in index linked Government bonds.

In real estate transactions, many rent adjustment clauses (and service charge caps) are index-linked against RPI.  This method of rent review is particularly popular in sale and leasebacks and other fixed income deals.

If the formulae used to calculate the RPI is altered in line with the CPI then the practical effect of such a change will be to reduce the increases in rent where they are linked to increases in the RPI. If the parties have negotiated clauses on the basis that the RPI would give a greater return then many will rile against this change whilst others may well argue that index-linking is designed to measure inflation and the formulae used to calculate the RPI do not accurately do so.

Either way, the current consultation may spell the end for the RPI as we know it.  For leases that have already been negotiated the issue will be whether such documents include any room to manoeuvre with the calculation.  Even the ability to re-negotiate a similar equivalent is unlikely to be practical solution. Until the results of the consultation are released early next year, it remains to be seen whether the future will breathe new life into the RPI.

The consultation ends on 30 November and can be found at: http://www.ons.gov.uk/ons/about-ons/user-engagement/consultations-and-surveys/national-statistician-s-consultation-on-options-for-improving-the-retail-prices-index/index.html.

The results of the consultation are due to be published in early 2013. Watch this space.

For further comment on the effect of the RPI on index-linked rent review clauses and generally, post a comment to John Condliffe, our leading real estate partner on the subject.


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